Foreign Banks Get a Break From IRS in Trump Tax Law's New Levy

(Bloomberg) -- The Internal Revenue Service is giving foreign-based banks with U.S. operations some leeway when calculating a major new international tax aimed at preventing global companies from shifting profits abroad.

Multinationals often transfer payments, such as interest or royalties, to their affiliates in low-tax jurisdictions to maximize deductions and minimize tax bills. Instead of applying the new BEAT, or base erosion and anti-abuse tax, to the entire payment, firms will only have to pay the tax on a portion of it, according to regulations proposed by the IRS Thursday.

President Donald Trump’s overhaul included the complicated BEAT provision, which was seen as particularly onerous for banks since they face a higher rate than other multinationals. Banks are also more service-oriented, so don’t qualify for some of the benefits that businesses with factories and machinery can use to minimize their BEAT. HSBC Holdings Plc, Mizuho Financial Group Inc. and Deutsche Bank AG have disclosed they’re likely to be affected by the new levy.

The BEAT rate is 5 percent this year, before increasing to 10 percent from 2019 to 2025. After that, it tops out at 12.5 percent. For banks and securities dealers, the rates are one percentage point higher.

The levy serves as a parallel tax system, where companies calculate their potential tax liabilities two ways: under the BEAT, which offers a lower rate applied to more income, and the U.S. corporate rate, which is 21 percent and has narrower applicability. Then they pay whichever is higher.

Post-Crisis Requirement

The tax overhaul slashed the corporate rate to 21 percent from 35 percent, and shifted the U.S. to a system of taxing its companies on their domestic profits only. Those changes required guardrails -- like BEAT and the tax on Gilti, or global intangible low-tax income -- to ensure multinationals pay at least something on their future overseas profits.

Corporations have been confused since the bill was signed into law about how broadly the tax would apply, according to Jose Murillo, leader of the International Tax Services practice at accounting firm Ernst & Young.

The rules are a relief to many large businesses that had received conflicting signals from lawmakers and Treasury officials in charge of writing the regulations about whether the BEAT would apply to the total amount of the service payment or just the additional cost of what the offshore affiliate is charging for the service.

The IRS move “clearly represents the better reading of the statute,” said David Noren, a partner at law firm McDermott Will & Emery.

The IRS proposal also addressed how BEAT interacts with a post-financial crisis requirement for banks to hold more long-term debt. Non-U.S. banks that have certain U.S. units were concerned that the requirement could mean that the interest paid on that debt would be subject to the BEAT. The agency said those payments are exempt and won’t be taken into account for BEAT liabilities.

The BEAT is estimated to raise $149.6 billion over a decade, according to the congressional non-partisan Joint Committee on Taxation. The tax applies to companies with revenue of at least $500 million and that have at least 3 percent of their tax deductions tied to offshore payments, or 2 percent for many financial services firms.

Arlene Fitzpatrick, a principal in EY’s national tax unit, said the regulations would allow foreign companies to exclude so-called effectively-connected income, which is generated from doing business within the U.S., from American units when calculating the tax. Back office operations and other services would also be excluded, she said.

Fitzpatrick, a former attorney adviser in the Treasury Department’s Office of Tax Policy, added that the rules were favorable for companies with net operating losses in previous years.

To contact the reporters on this story: Laura Davison in Washington at ldavison4@bloomberg.net;Lynnley Browning in New York at lbrowning4@bloomberg.net

To contact the editors responsible for this story: Alexis Leondis at aleondis@bloomberg.net, John Harney

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